Yellen vs. the BIS: whose thesis makes better sense? More than twenty noted observers weigh in.

• Position: A SYMPOSIUM OF VIEWS

For the first time since the monetarist vs. Keynesian debate of the 1970s, the economic policy world is in stark intellectual disagreement. At issue is the role of monetary policy and financial bubbles. The most recent annual report of the Bank for International Settlements highlights the limitations of monetary stimulus by the world's major central banks and the dangers ahead from financial bubbles. States the BIS report: "[L]ow interest rates can also have the perverse effect of incentivising borrowers to take on even more debt, making an eventual rise in rates even more costly if debt continues to grow.... [L]ow interest rates do not solve the problem of high debt." Federal Reserve Chair Janet Yellen has been quick to counterattack, arguing that the extraordinary monetary measures taken by the major central banks since the 2008 financial crisis reflect the prudent policy choice. States Yellen: "[Wjhether it's because of slower productivity growth or headwinds from the financial crisis or demographic trends ... so-called equilibrium real interest rates may be at a lower level than we've seen historically." Former Treasury Secretary Larry Summers adds his thesis that the economy's foundational underpinnings are so weak, financial bubbles may be perpetually necessary for the world to achieve sustainable growth.

Which side offers the more credible policy guide in coming years for the industrialized world economies? The BIS or the Yellen thesis?

HANS-WERNER SINN

President, Ho Institute for Economic Research, and Professor of Economics and Public Finance, University of Munich

Our banks are no longer what they were a hundred years ago, when they needed a third of their assets as equity capital to convince creditors to lend them money. Under the increasing protection of informal bailout guarantees by governments and formal deposit insurance schemes, they have become highly leveraged gambling machines with typically only 2 percent to 5 percent equity on their balance sheets, investing in overly risky and correlated assets, distributing the profits to shareholders when they come, and relying on bail-outs when systemic risks materialize. Given that policymakers do not dare risk the collapse of the economy in such cases, they see no alternative to opening taxpayers' wallets.

In the current financial crisis, even central banks helped avoid the losses by providing ample liquidity and taking fiscal risk-absorbing measures. The Fed tripled its balance sheet by printing money to buy huge volumes of assets from private portfolios to sustain their market values and protect the banks and other financial institutions from equity losses ("quantitative easing"). And the ECB allowed the central banks of Europe's six crisis countries (Greece, Ireland, Portugal, Spain, Italy, and Cypms), which represent 30 percent of the eurozone's GDP, to print three-quarters of its entire money stock, lending it to local commercial banks at below-market interest rates against bad collateral, often even no-investment grade. These policies allowed the banks to gain fat and rescued many zombie banks. However, while aiming at short-run stability, both the ECB and the Fed became part of the commercial banks' long-run gambling strategy. They turned into powerful bail-out institutions, more powerful than all the direct fiscal bailout and rescue funds taken together. The central bank bailouts rescued the banks, but encouraged them to again invest the funds savers entrusted to them in dubious uses that otherwise would not be profitable.

Some say this is no problem, as central banks can absorb risks without burdening taxpayers. But this is not true, as taxpayers will either have to compensate for the missing profit distributions of the central banks to the respective governments or will have to bear the cost of outright fiscal transfers to borrowers (such as some local governments in Europe) to prevent the losses from materializing on the central banks' balance sheets. Seen this way, the central banks' free-of-charge lender-of-last-resort insurance is a hidden subsidy for risky and unprofitable investments with taxpayer money, which results in the usual welfare and growth losses for the economy.

There clearly is a trade-off in central bank policies between short-run stability and long-run efficiency of the capital market in terms of allocating savings efficiently to rival uses, and it is hard to judge whether central banks have found the right balance between alternative goals. My impression is that they have been leaning too much towards the short-run stability goal, because their mindsets were captured by the interests of the financial industry, and because reckless public borrowers were often over-represented in their decision-making bodies. This bias has minimized the probability of a short-term financial crash, but it will also lead to long-run stagnation of the Japanese type, impose substantial risk on public budgets, undermine the stability of society, and reduce the Western world's dynamism. A policy of harder budget constraints placing more weight on long-run incentives might serve society better.

SEBASTIAN DULLIEN

Professor for International Economics, HTW Berlin-University of Applied Sciences, and Senior Policy Fellow, European Council on Foreign Relations

At the moment, central banks should continue to run a very lax monetary policy until the major developed economies have reached a self-sustained point in the economic recovery. The notion that central banks should keep their interest rates at an elevated level because excess liquidity could cause new speculative bubbles and endanger financial stability is misguided on at least three counts.

First, empirically, the link between low interest rates and financial market bubbles is highly shaky. If we look at the large bubbles of the twentieth century, at least two major ones cannot be associated with particularly low interest rates. The stock market bubble in the late 1920s developed at a time of moderate real interest rates. While the Fed lowered its discount rate to 3.5 percent for a while in 1927, this was not very low in real terms as prices were actually falling. Moreover, the Fed reversed course pretty quickly at that time, so interest rates did not remain that low for long. Also, the stock market bubble of the 1980s developed against the background of rather high interest rates--the federal funds target rate was between 6 percent and 8 percent when stock market prices took off in the second half of the 1980s. There is no convincing evidence that low interest rates in an environment of sluggish growth actually produce bubbles.

Second, there is no real alternative to low interest rates now. No matter whether we have moved towards a fundamentally lower equilibrium interest rate or whether we are in a prolonged cyclical weakness, low interest rates are warranted. If we are faced with lower equilibrium interest rates, then keeping central bank rates excessively high will ultimately push the economy into deflation. If equilibrium interest rates have not changed, but we are only in an extended cyclical trough, then keeping interest rates high would prevent a swift recovery.

Third, what really endangers debt sustainability and financial stability is deflation, not low interest rates. If the opponents of lax monetary policy fear that low interest rates lead to higher debt levels, they should remember that debt sustainability is about the relationship between nominal debt and nominal income. Deflation is a process which most certainly brings up the debt-to-income ratio as debts are fixed in nominal terms while nominal incomes contract in a deflation. If one compares the United States and the euro area in the years just after the global economic and financial crisis after 2008, one can see that the U.S. economy deleveraged much more quickly than the euro area because the U.S. Federal Reserve was running a more expansionary monetary policy than the European Central Bank.

Thus, acting on Yellen's hypothesis clearly makes more sense than following the BIS advice.

JACQUES ATTALI

President, PlaNet Finance, and former President, European Bank for Reconstruction and Development

In 2001, in the aftermath of the dot-com bubble bursting, the U.S. Federal Reserve decided to lower its rates in order to spur economic activity and employment. Global growth then resumed, fueled by the rising indebtedness of all actors. On the U.S. real estate market, a housing bubble and a credit bubble built up.

In 2008, the bursting of these bubbles triggered a new global crisis. To address its consequences, the central banks of advanced economies have resorted to a set of conventional and unconventional monetary decisions which have brought their policy rates close to the zero bound, and then-balance sheets to an aggregate $10 trillion.

Today, all of them are, to some extent, facing the same conundrum: engaging in policy normalization too early might stifle a fragile recovery, while maintaining an accommodative stance for too long may favor the build-up of financial imbalances in the long run, which "has happened often enough in the past," according to the BIS.

Hence the debates on the necessity and desirable pace of interest rate increases, which in turn raise the question of rates' equilibrium level and of the "right" policy rules and inflation targets.

While these issues need to be addressed, the importance that they are taking in the public debate and the high expectations which are placed upon central banks' decisions should not lead citizens and policymakers to overlook one key observation: recovery is not here yet, and monetary policy cannot bring it alone.

First, monetary policy transmission mechanisms are broken, especially in the euro area: low interest rates fail to entice banks to lend to the private sector and firms to invest. Diverted from its objectives, further easing may therefore end up...